Headwaters: Awaiting an Increase in Infrastructure Spending and Home Building

Feb. 5.09 | About: Headwaters Incorporated (HW)

For the first quarter of its 2009 fiscal year Headwaters, Inc. (NYSE:HW) reported a net loss of 2¢ per share against the consensus estimate of a 4¢ profit. For the same quarter in the prior year HW had a 1¢ per share loss excluding discontinued and sold business lines (Call Transcript).

I started following Headwaters a little over a year ago as the company started working its business plan to generate new revenues as the proceeds from its Section 45K clean energy business wound down when the section of the tax code expired. It has been working on transferring its clean energy technology to the building of facilities that process waste coal into usable / salable high quality coal. The fall in energy prices, the housing crash and the general economic slowdown have had significant impact on Headwaters’ three major business lines, slowing the companies return to strong profitability. Here is a quick outline of the company's major business lines:

Building Materials: Headwaters manufactures and sells block, stone and other building materials used primarily in new home construction and remodeling. Revenues for this business declined 17% from the same quarter a year earlier and accounted for 53% of total sales. HW has been aggressive in bringing out new products and cutting costs in building materials, but this segment will struggle until new home building starts to rebound.

Coal Combustion Products: Headwaters processes fly ash from the burning of coal in electricity generating plants and sells the end product as an additive to Portland cement use. The fly ash HW sells results in stronger concrete and significantly reduces the amount of CO2 produced related to new concrete construction. About 25% of the segment's revenues are from service contracts with power generators. These sales could grow significantly if government infrastructure spending increases along with the current administration’s emphasis on reducing greenhouse gases. In the last quarter 40% of HW’s revenues were from this segment.

Energy: For a little over one year Headwaters has been ramping up its coal cleaning operation. It now has 11 facilities in operation at various stages of ramp up. When fully operational these facilities will be able to clean 5 million tons of coal per year. In the quarter HW sold 336,000 tons of coal compared with 85,000 tons sold a year earlier. Merchant coal sales (excluding tolling sales) increased 9-fold, year over year. With cutbacks in steel production the higher value metallic coal market has disappeared for Headwaters and they are currently primarily selling steam coal. Energy sales accounted for 6.4% of revenues in the quarter.

In tolling, a power marketer (or fuel supplier) contracts with the operator of a generating plant to convert the power marketer’s fuel into electricity, which is delivered over a transmission line to an agreed-upon location. The generator does not take title to either the fuel or the electricity, but is paid a tolling fee for its services.

Headwaters’ revenues are slowest in the last and 1st calendar quarters of the year and analysts are projecting a loss for the next quarter. Management is projecting earnings for all of 2009 at between 35¢ and 70¢ per share. The wide range is due to the uncertainty of the timing of recoveries in the housing and energy sectors. At this time Headwaters is a company with several lines of business that should thrive when infrastructure spending and home building start to increase. The question is how long will the company and investors have to wait until that day arrives. At this point I think the stock would be interesting to investors with at least a 2-year time frame.

Disclosure: HW is a component of this site’s Opportunities Portfolio and a personal holding.